Too Much Consuming
Reseach for Online Investors

by John Dalt

9/16/10

The Administration wants to stimulate the economy to increase consumption, hoping this is “what firms need to start hiring.” Do we need to consume more, or invest more? Is the economy improved from the pull of consumption, or the push of investment? We wrote that capital goods production is the best way to build a recovery in the economy on October 10, 2009 in More Stimulus, Less Growth.

Purchasing capital goods means companies are making good old fashioned investments.  The problem the U.S. ran into in the 1970’s was scarcity of capital.  Capital must be available, at competitive rates, for business to borrow, in order to make investments in capital goods.

Business decisions are made to invest in capital goods when the return on the investment is greater than the cost of capital.  Where does the money come from?  The neighborhood bank.  Where does the bank get the money?  From savings accounts.  How much do we save?  Not enough.

A recent article in the Harvard Business Review has some sobering statistics on the American Economy.  Chris Meyer and Julia Kirby wrote, “Does the US Really Need More Consumption?”  Ms. Kirby is a senior editor at the Review and Mr. Kirby is a consultant and author.

The U.S. leads the world (along with Greece), as private consumption makes up 70% of our GDP.  France and Germany are at 57%, Brazil is 61%, India’s 65%, Sweden 47%, and China is at 35%.

We all like our trinkets and can’t live without the latest popular gizmo, but does that money spent on consumer items benefit our economy?  It certainly has benefited China as our supplier of all things cheap.

In business, politics and life; the danger is in the unintended consequences.  If we do so and so, what else happens we didn’t anticipate?  If we spend our available income on gadgets and fashion, that gives us instant gratification.  What do we forgo as a society to have these things?

The answer is investment capital.  When we spend all of our disposable income on trinkets and go into debt, there is less money saved.  The banks have less to loan, interest rates go up.  Capital goods are not purchased, and the economy does not grow.

China invests 42.3% of GDP to keep those trinket production lines running.  Vietnam invests 41.6%.  Greece, France and Germany invest 22.6%, 22% and 18%.  How much does the U.S. invest as a percentage of GDP?  The U.S. invests only 15.4% of GDP.

The obvious fact is that present interest rates are low.  So why aren’t U.S. businesses investing in capital goods?  Because of political uncertainty, and expectations that interest rates will increase dramatically in the near future.  Would you invest a million dollars in machinery for a fifteen year payout, if the interest payments were likely to go from $60,000 per year to $100,000 per year?

The government can enact tax laws that will encourage investment in capital goods such as an “Investment Tax Credit.”  This would tilt the decision and serve to push some businesses to make investments in capital goods.  But, the Fed pumping money into the financial system is not sustainable, and must eventually be replaced by a stable, balanced economic model.

Our quote today:
You can never get enough of what you don’t need to make you happy.—Eric Hoffer

The information presented in this newsletter is based on generally available news releases, corporate filings, current events, interviews and the editor’s opinions.  It may contain errors and you should not make investment decisions based solely on what you believe you have read here.  Do your own research, it is your money.  If you lose it, it is your responsibility, not ours or your grandmothers!  The editor may or may not have a position in any securities discussed.  The editor may have held a position in a security earlier, or in the future.

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